Country Report Greece
The outlook of the Greek economy outlook is improving, while progress under the bailout program remains broadly on track. That said, future political stability cannot be taken for granted and might weigh on the ability to push through with reforms.
Strengths (+) and weaknesses (-)
(+) Euro area membership
European financial assistance has protected the country against a chaotic government default. Please note that membership comes at the cost of a loss of national exchange rate policy.
(-) High public debt
A history of weak fiscal discipline, combined with the deep and long economic contraction since 2008, has resulted in a very high gross public debt ratio of 177% of GDP in 2013.
(-) Weak competitiveness
Rising labour costs in the years ahead of the crisis, in combination with dependency on the price-sensitive tourism sector, have resulted in a weak export growth in recent years.
(-) Poor institutional quality
Greece is lagging other European countries in several indices of institutional strength, like the rule of law, ease of doing business and the corruption index.
1. Economic outlook is improving
Recent data show that the Greek economy has finally started its recovery. The significant decline of the year-on-year GDP volume (which we use in the absence of seasonally adjusted GDP figures) suggests that Greece has ended its recession (figure 1). However, please note that the volume of economic activity end-2013 is almost 24% below the pre-crisis peak. The steady rise of sentiment indicators suggests that the recovery will continue going forward, albeit almost completely export-driven. It is important to note that there is much uncertainty about the size of Greece’s output gap and the speed and extent with which it will be closed (the European Commission estimates this output gap at 9.4% in 2014, with GDP growth of 0.6% in 2014). Despite the uncertainty on the pace of the future recovery, it remains clear that the external rebalancing proceeds in a much quicker way than internal rebalancing. Greece posted its first current account surplus in 13Q3 (on a 4-quarter average, since the start of the data in 1980), albeit mainly driven by import contraction. However, with an extremely high unemployment rate of 27.5%, Greece is still far away from internal balance. Unfortunately, given the ongoing austerity effort, private deleveraging and low wage growth, we do not expect that internal balance, and thereby lower unemployment, will be reached quickly going forward.
2. Update on bailout program
End March, the Eurogroup gave green light to the next disbursement of Greece’s bailout financing. The new tranche equals €8.3bn, of which €2bn is conditioned to further policy measures. According to a preliminary statement by the troika on the completion of the fifth IMF-review, progress on the bailout program shows mixed results, with significant progress on the fiscal performance but ongoing delays regarding the implementation of structural reforms. According to the EC Winter Forecast the budget deficit is expected to decline to 2.2%-GDP this year (primary surplus of 2.7%-GDP), which is substantially better than the target (below 3%-GDP in 2016). Gross government debt is expected to peak this year at 177%-GDP. Given the uncertain economic outlook and our expectation of only modest future inflation (currently deflation of -1.5%), we believe the Greek government debt is still unsustainable. As part of the negotiations with the IMF on the restructuring of the Greek government debt end-2012, European leaders promised to take further measures to bring down Greek debt to 124%-GDP by 2020, and ‘substantially’ below 110%-GDP in 2022. Principal haircuts on, for example, the Greek loan facility cannot be excluded, especially given the estimate of the IMF that currently more than 2/3 of all Greek government debt is in hands of official creditors. Regarding structural reforms, there has been progress in reforming public administration, liberalizing product and service markets and in adjusting the pension system. Nevertheless, labour market reforms and privatization efforts are still behind schedule. At least partly due to the gradual progress under the bailout program, investor confidence increased substantially last year, reflected by the drop in yields on 10 year government bonds to 6.1%, see figure 2. Recently, the Greek government even successfully issued a 5 year bond (yield 4.75%) for the first time in four years. Please note that a continuation of the general drop in government bond yields across the eurozone periphery –which can be partly attributed to a return of confidence after the ‘whatever it takes’ pledge by ECB-president Draghi- cannot be taken for granted as it also depends on political stability and liquidity in global financial markets. We believe a third bail-out package remains necessary after 2014. However, given the upcoming European elections, creditor countries (especially Germany) want to postpone the discussion on a third bailout to the second half of 2014.
3. Coalition instability might lead to early elections
Despite the fact that the current coalition of New Democracy (ND) and PASOK has been in office longer than previously thought, we do not take political stability for granted in the coming years. In spite of the gradually improved economic outlook, public support for the coalition has decreased substantially since the parliamentary elections in June 2012. Due to several political disputes and the defection of the third coalition party DIMAR (17 seats) in June 2013, the remaining coalition has a very slim parliamentary majority (152 out of 300 seats). Against this background, the risk of early elections somewhere this or next year is substantial. This might be the result of a further defection of seats or due to a failure to find agreement with the opposition to put forward a new presidential-candidate by February 2015. We believe this is a potential stumbling block as a 2/3 parliamentary majority is required. In case of early elections, the political future of Greece is uncertain. According to recent polls, the coalition parties ND and PASOK would only receive 31% of the votes, compared to 42% at the June 2012 elections. ND and Syriza (both around 25%) are leading the polls, while there is strong rise of several smaller parties, both on the (extreme) left and right of the political spectrum. Despite Syriza’s strong rhetoric against the current austerity and reform agenda, they might tone down in case they would end up in a coalition government. Although such a coalition would definitely frustrate the relation with the troika, we believe the chance of a eurozone exit is small. Nevertheless, we expect the political fragmentation to lead to a political landscape in which the formation of a stable, pro-European coalition will prove increasingly difficult, which will weigh on the ability to push through substantial structural reforms.
Between the introduction of the euro in 1999 and the start of the financial crisis in 2008, the services-oriented (tourism) Greek economy experienced a rapid deterioration of its current account balance. A main driver of this deterioration was the quick rise of the government’s budget deficit. After the financial crisis, investors started to worry about Greek debt sustainability. As interest rates on government bonds rose steeply, Europe and the IMF decided to provide financial assistance in May 2010 (€110 bn). In 2012 more financial assistance was provided via the European Financial Stability Fund (EFSF) and the IMF (together €164 bn) and via a restructuring of government debt hold by the private sector. Strict conditionality was applied to this assistance, as a result of which Greece has undergone an enormous austerity effort in recent years and has made much progress regarding the implementation of structural reforms. Despite these efforts the institutional quality (e.g. business climate, corruption) of Greece is still lagging its European peers. The robust austerity effort, together with private deleveraging and weak external demand, have resulted in a long and deep contraction of economic activity, which was end 2013 24% below its pre-crisis peak. Although the country will eventually reap the fruits of structural reforms, the short term costs of this adjustment process are extremely high. As a result, the alarming unemployment rate (27%) makes it very challenging for the coalition government to further implement unpopular reforms. It should be noted that since the restoration of democracy in 1974 –after seven years of military rule- Greece has had very few experience with coalition governments. Especially since the crisis, political instability is high as the political parties of the traditional two-party system (New Democracy and PASOK) have lost much electoral support to the anti-austerity party Syriza.